Gold may lose sheen this year

The international gold price had surpassed $1,200 per ounce in December 2009, hitting a historical high. Gold finished 2009 up 24.4 per cent, its ninth consecutive annual gain. The sharp increase in 2009 was primarily driven by dollar depreciation and speculation. Since March 9, 2009 (when the US dollar index hit the year’s peak) till the end of October 2009, the dollar-denominated gold price climbed 13.4 per cent, comparable to the 14.3 per cent decrease of the dollar index in the same period.

In November 2009, speculation became the dominant force to spur the gold price. US Commodity Futures Trading Commission data shows that the long position on gold futures contracts was dominated by speculative demand last year. In 2009, money managers were net long by 1,95,825 contracts, a sharp increase of 113 per cent from a year earlier.

On the other hand, gold demand drivers are still weak. There are four main categories for gold demand — jewellery, industrial, retail investment and ETFs (exchange traded funds). Jewellery, which consistently accounts for over 60 per cent of the total demand, is a key component for underpinning the overall demand for gold.

Three out of four categories in gold demand (jewellery, industrial and retail investment) recorded a decline in the first three quarters of 2009, with ETF being the only component to register an increase. Investors believe central banks’ purchases to diversify foreign reserves could help push up the gold price. Reserve Bank of India purchased 200 tonnes from the International Monetary Fund from between October 19 and 30 last year.

In fact, central banks’ buying cannot by any means justify the high gold price because there were only a few central banks that participated in the market and the volume of the buying was insignificant.

Besides, it is widely believed that the Chinese central bank is eager to buy gold to diversify its foreign reserves. However, the actual average of annual gold purchase from China could be much smaller than the market expected.

Lastly, the downward risk is high for the gold price. Apart from the expensive price, there are some other negative factors. In fact, we don’t see any threat of hyperinflation. In addition, the global economy has just started to recover and investors have regained their risk appetite. Hence, the demand for riskier assets has increased. Coupled with the weak demand for gold, its price is likely to correct down. In addition, investors should note that gold does not provide interest income. If the US Federal Reserve starts to raise interest rates, investors will re-embrace the US dollar and re-price on gold. The gold price would then experience a nasty correction.

(The author is Senior Research Analyst, Fundsupermart.com)